Bloody Friday
Summary
- On Friday, the market ran fresh out of patience with the increasingly aggressive trade banter.
- This was a truly manic week that started and ended with precipitous declines in U.S. stocks.
- The major risk after Thursday evening is that the Trump administration ultimately backs China into a corner by proposing more in tariffs than China imports in U.S. goods.
- In that scenario, Beijing may "go nuclear" (so to speak).
I regret to inform you (again) that the threat of a trade war with China is real.
And if you don't believe me (or your own eyes and ears), then just ask Treasury Secretary Steve Mnuchin, who said as much on Friday afternoon in an interview with CNBC. Here's the actual quote:
I'm cautiously optimistic that we will be able to work this out. But there is the potential of a trade war.
Yes, there is the "potential" for that, and the odds of the situation spiraling even further out of control increased materially on Thursday evening when the Trump administration decided to look into the possibility of proposing an additional $100 billion in tariffs on China in retaliation for Beijing's retaliation (and no, there are no typos there).
This is precisely what everyone was afraid of - one retaliation begets another until it becomes impossible to distinguish "offense" from "defense" and "provocation" from "reaction".
In his official statement, Trump cited China's move to counter the 301 list, characterizing Beijing's retaliatory measures as "unfair". That's not entirely consistent with Wilbur Ross's Wednesday interviews in which the Commerce Secretary called China's measures both "proportionate" and "expected."
The reaction from markets was not favorable. The S&P (SPY) dove more than 2% Friday, closing the week on a decidedly sour note after kicking things off Monday with the worst start to a second quarter in nearly nine decades.
(Heisenberg)
Needless to say, that chart just underscores the notion that 2018 is nothing like last year in terms of precipitous swings in either direction.
You'll recall that on Wednesday evening, in "This Means War", I talked at length about the political calculus for Trump. Specifically, I said the following about China's soybean broadside:
Soybean farmers are furious - and that's an understatement. The panicked response from growers (found at the link there) underscores the notion that China is acutely aware of what's going on here and is fully prepared to try and neutralize any political points Trump hopes to score. Needless to say, the soybean bit is just one example of a dynamic that's playing out across multiple industries.
I also highlighted a few passages from Goldman's take. Here's the key bit:
We view the inclusion of soybeans in [Wednesday's] announcement as political in nature and reflective of the escalation of the trade dispute with the US. Soybean tariffs impact US Midwest political swing states and come at a cost that China appears willing to pay.
The point: it doesn't take a leap of logic (nor does it require saying anything necessarily pejorative about the Trump administration) to come to the conclusion that Thursday evening's escalation was motived by China's rather transparent attempt to hit Trump and the GOP where it hurts politically. Indeed, Trump basically acknowledged as much in his statement, which contained the following passage:
I have also instructed the Secretary of Agriculture to use his broad authority to implement a plan to protect [America's] farmers and agricultural interests.
There you go. It also looks like Trump is effectively trying to make it impossible for China to retaliate with tariffs. If the U.S. were to up the ante to $150 billion in total tariffs, that would exceed U.S. goods exports to China:
(Heisenberg)
Do you see the problem with that? If not, allow me to quickly explain. It would corner Beijing into going the so-called "nuclear route", and the thing investors need to understand is that China actually has several "nuclear" options, two of which are devaluing the yuan and selling Treasurys (TLT). Here's what Goldman had to say about this on Friday in the wake of the latest escalations:
In 2017, the US exported $131 billion in goods to China and imported $506 billion [so] if the US were to impose tariffs on an additional $100 billion on imports, taking the total to $150bn, China would be unable to respond fully through retaliatory tariffs as there are simply not enough US exports to retaliate against. However, China would have other means of retaliation. Although China would be unable to fully retaliate through tariffs on goods in the event that the White House imposed sanctions on $150 billion in imports, Chinese policymakers could take other steps to retaliate. First, a currency depreciation could be used to offset some of the effect of tariffs. Second, Chinese authorities could sell some of its large official-sector holdings of US Treasuries, which would lead to a tightening of US financial conditions. Third, Chinese authorities could limit access for US companies to the Chinese domestic market, particularly in the services sector, where the US exports $56 billion in services annually and runs a $38 billion surplus.
None of that would be good news for markets. In fact, all of it would be decisively bad. A sudden devaluation of the yuan (as opposed to say, a staggered devaluation) could destabilize things literally overnight. If you need proof of that, go back and look at what happened in August of 2015 following the yuan devaluation.
As far as the Treasury liquidation is concerned, that's an issue that markets have been grappling with all year since Bloomberg suggested China was looking at diversifying away from U.S. debt in early January. I've talked exhaustively both here and on my site about the feasibility of going this route for China. There's a long list of reasons to think this isn't a desirable option for Beijing, but it's by no means out of the question. If you want an in-depth discussion of this, see here, but here's Bloomberg with the simple reason why China would want to be careful:
Few China watchers would disagree that dumping the country's vast holdings of Treasuries, officially standing at $1.2 trillion, represents a nuclear option. After all, it would impose losses on China itself, and potentially cause mayhem in the world's deepest bond market.
For now, the long end is of course supported by the risk-off sentiment that's intermittently swept through markets amid the trade tensions. On Friday, amid the chaos, 10Y yields dove 6bp, breaking below the 50-DMA at ~2.83%.
(Heisenberg)
If you look at S&P futures, you can see how truly manic the last several days have been. The following chart is annotated to show the moment just after 3:45 a.m. ET on Wednesday when China's reciprocal measures were proposed and the moment on Thursday evening when the Trump administration said it was considering proposing an additional $100 billion in tariffs in connection with the 301 probe:
(Heisenberg)
Obviously, there is nothing particularly comforting about that. This is when I get to quote myself again. Recall this from the "This Means War" post linked above:
The bad news is that this is playing out against an exceptionally fraught political backdrop and indeed it seems as though markets have become almost completely beholden to politics over the past four weeks. Ultimately, that will spell trouble if the fundamentals are relegated to the backburner for too long.
Multiple analysts and traders have reiterated that sentiment over the past 48 hours.
"It's becoming childish," AMP Capital Investors Nader Naeimi told Bloomberg on Friday, adding that "at some point investors will say enough is enough, there's just too much political volatility now."
And here's what former trader turned Bloomberg columnist Richard Breslow had to say in his Thursday missive:
And there lies the problem with opinions being so diametrically opposed. Today, it's not things have calmed down a bit. It's trade tensions ebb. "Bellicose" has been replaced with "Calm Reasoning"
We've gone from "get out, don't you know we're in a correction that's heading straight to becoming a bear market" to "Yo loser, you have to be in it to win it. And by the way, where's your stinkin' correction now?"
Since he wrote those words less than 36 hours ago, we've reversed course again. Now, we're back to "get out!"
Where this goes from here is an open question, but just to reiterate the point above about China running out of options, Washington is backing Beijing into a corner with this. If the Trump administration goes ahead and publishes a list in conjunction with the proposed additional $100 billion in tariffs, we could well be on the fast track to a "surprisingly" weak yuan (CYB) fixing in the not-so-distant future.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (616)
China has come to their senses! Trumps good relationship with Xi and his negotiating skills will result in a win/win for both Countries.OK Lefties...let 'er rip and tell me how bad this is!>>A global equity rally was triggered as Chinese President Xi told the Boao Forum that Beijing plans to give foreign companies greater access to financial and manufacturing sectors. He also talked about a cut in tariffs on car imports and an improvement in protection of intellectual property, among other measures. While many of the measures had been previously touted by Xi, investors cheered the lack of any escalation in rhetoric.“In a world aspiring for peace and development, the Cold War and zero-sum mentality look even more out of place,” said Xi.<<
And let us know when he actually does it.
Don't forget the major way to Make America Great Again is... to exploit foreign labor.
I know it is hard for you to accept it, but you can't fight the chart. $3/hour in Mexico vs $25+benefits in US - who are you kidding? Follow the money and you get to the truth.
They must think people are pretty gullible to believe such nonsense, because they are not going to do anything of the kind.
China has already suffered with capital flight in recent years, and it started to become a serious drain on reserves. The foolish threats in the context of a trade war would be far more severe than recent capital flight, and should make it obvious as to why they will not follow this path.
- See the Triffin Dilemma
- http://bit.ly/1UUk4NjFood for thought . . .
http://bit.ly/2IxFUYD"If Japan’s participation in the WTO consultations is accepted, Tokyo is set to say that the Chinese measure regarding technology transfer is distorting the competitive environment between companies, the source said."
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EU considering taking China to WTO over IP practiceshttp://bit.ly/2HiNGpI"The European Commission is “closely examining” the option of filing complaints against China before the World Trade Organisation for their rules and practices on intellectual property, a spokesperson told EURACTIV on Wednesday (4 April)."
And he got NAFTA passed too. https://nyti.ms/2GKoBr2The Big Question is what was the "Pay to Play" reward??
Escalation could be very possible at this point, and has been reported by talking to officials and as outlined in this article.
A common source of inflationary pressure in China is often reported as food inflation, more specifically often pork prices. Some of the other talk centered on energy, specifically NGL's from the US is also an interesting choice of focus. Seems the Chinese chose to target what they thought would hurt the US most, without consideration for what is actually the source of their worst potential problems, food and energy inflation. Expensive food and energy is a big problem for China, and a source for unrest in the country when the population is unhappy.
Inflation is an especially important consideration for the Chinese, especially in these two key areas, because an unhappy population is the largest singular concern for the leadership of the country.
No one wants to sacrifice anything for the good of the country.
Most have no idea of the sacrifices made in the 40's to keep us free. Not only the military but people at home had rationing and were living day to day after coming out of the great depression.
China has been stealing from us for years but the common Wall Street attitude is we can't do anything about it ! They forgot to add "without it hurting us".
Suck it up ! you have a President who will take them to task but are we willing to do our part?I AM
I am completely agree with you. Just don't ask me to sacrifice on everything in life and politicians live a lavish life. It must be top-bottom... leaders must lead by example, until then, I will do whatever I feel appropriate from my side.
THEIR ENTIRE LIVES, SO SAD, AND THIS IS THE ONLY WAY THEY KNOW HOW TO THINK, and many much younger are the product of such people, the biologic issue of people who graduating from high schools in the 1990s or coming from other continents.....wow, so scary.............. and all of this is because America became fat happy and stupid about 35 years ago, give or take, and we started giving our manufacturing base away. Fat stupid and happy is also another tell, another Canary in a coal mine? Have you ever looked a the physiques of american's these days....Scary Terry to put it mildly. Another Canary in a Coal Mine. America has lost 55,000 factories since 1991, and there are almost no more to lose as they are almost all gone now. Very sad. We lost 15,000 in the last 9 years alone. So anyway, Trump an independent businessman hated by the wall street and corporate scum, has seen all of this happen and his trade policy is a result of this and he will never budge for the time being, and all of this scares wall street. America reduced to credit card bill collectors and dog walkers and social media types. so sad o so sad. O yes, whole small towns of druggies and depressed young people, and parents who cannot stop their adult children from doing the drugs even where the child lives with their parents, as so many are now forced by economics to do. bUT BUT BUT, ........THE REAL REASON FOR THE MAJOR BEAR MARKET WE ARE HEADING INTO IS THE USUAL THING: VALUATIONS.
The s and p stands at about a 25 PE from here on out, if real accounting and not fake accounting is used, and the historical norm is a 12 PE. Right now another canary in the coal mine is consumer debt. GET THIS: IT IS NOW 40% HIGHER than it was at the top of the last bubble, the 2008 crash, where the S and P went on to lost 55% of its ENTIRE VALUE, TOP TO BOTTOM OF THE GREAT FINANCIAL CRISIS. People especially young people and young couples are trying to use credit card debt which is so awful, like heroine, to maintain a standard of living, but credit cards are just so awful and it will not work. Go to Shadow stats.com and see the true picture of America. In the CIA, they call it, "beyond salvage," when they make the decision to murder somebody, like they did jfk in another world, a world so different from today it ain't funny.........it is tragic the world's are so different if you want to know the truth. So the larger picture, to finish this concept, is that the current market is now one of the top 4 all time mania markets of all time: right there with 1929, 2000, and 2008, and in some ways even higher bubble, more of a "quiet mania." You can say, well heck, the emerging markets are substantially cheaper and I agree, you can invest there if you want to try and escape. But remember: WHEN AMERICA SNEEZES THE WORLD GETS A COLD. so I think you can try to run into those foreigner equities, but you cannot hide. A lot of this board has health care people on it, and you can try to run into health care which is considered defensive, or so wall street shills will tell you, but guess what, health care portfolios were crushed in 2008, so there is that lie as well, squashed. You cannot even hide in Gold, which also was hit in 2008 but sort of held its own, but gold miners were decimated for over a year. Gold and silver stocks that sold for 35 bucks could be bought for under ten bucks at the bottom............so forget about that. And the current general market cannot hide by being propped up by the Fed dropping rates which is what it did in 2008. They dropped rates like 17 straight times starting back then but guess what, rates are now close to zero so that weapon is gone also. The FED MAKE NO MISTAKE, IS RAISING RATES, AND THE FED CHAIRMAN SAID ONCE AGAIN YESTERDAY, WHICH IS REALLY WHY THE MARKET TANKED 500 PTS.....he ain't backing down. The Fed is also draining money, not doing the old quantatitive easing scam. The phrase is QT now. tightening. And the 3 million plus jobs that have been created in the last year, reversing a 25 year trend, is not nearly enough. These are nice and helpful but are almost nothing compared to the steamroller of events that now must and will take place, when the punch bowl is being taken away from the drunks and the kiddies, which it is. THE GENERAL MARKET IS GONNA GET STEADILY SQUASHED AND WE ARE AT THE TOP.
And right now the old buy the dip in this 9 year bull market is gonna be sell the rip, sell the recovery from here on out. Remember, The current bull market was 9 years old, the second longest in u.s. history, but it ended this year starting in February. It lasted 104 months, the longest having been 120 months, and we are about to be cleansed once again, and there is nothing anybody can do about it.
so protect your portfolios. I am very good at the stock market, as some here will remember. i HAVE SEEN THIS STOCK GET DESTROYED THESE PAST 3 YEARS, and in truth it has been painful, but I made well over a million dollars on my ownership of avxl, dumping it all in a single day, at the highs, so I always have had a soft spot for it, always watching its demise from afar, seeing the new hopers showing up every week on this board, reading the old steady eddies who have said I am wrong and they are right these 3 years, while their ports have slowly been crushed, and truly, that has not been a fun thing. When I was younger this happened to me from time to time as well...........so take it from a 400 hitter, now is not the time to be investing at all in the stock market. BUY YOUR FAVORITE STOCK NEXT SUMMER AT A FABULOUS FIFTY PERCENT DISCOUNT FROM YESTERDAY'S CLOSE, which is what yours truly is gonna do. ......Have you checked your own batting average recently? I have been doing this stock market thing for over 30 years and have the scars to prove it. There are a huge number of truthful articles that are bearish that are just now appearing in financial pages since ordinarily most of this stuff is hidden or not written at all, but now these articles are like the bursting of a pipe, just check out seeking alpha as an example..........another CANARY IN A COAL MINE FOR SURE.